You’ve seen all the headline news stories about the Fed changing its tone in recent weeks. The Fed is going to pause rate hikes. And it will think about slowing the pace of balance sheet “normalization,” if the market seems to need it. As you know, normalization is just a euphemism for shrinking its balance sheet and draining money from the banking system. And that is assuredly something frightful. The Fed is now doing its darndest to make it seem less so.
Along with the Fed suddenly singing soothing lullabies to the market we’ve all heard the sweet talk from the US Treasury about calling in the bankers and the PPT, all of whom cheerily profess to love you and caring about you and your investments. It’s all about feeling good.
Whether they were really manipulating the market or not, I would hope that you have no doubt that the manipulators were doing their best to manipulate you and your fellow investors over the past few weeks. But what about all those soothing words? Do they matter? Or is it true that money talks, and you know what walks?
Well here’s something for you to look at that should concern you. It suggests that bankers have all too quickly forgotten the lessons of the past, and that once again they have their heads up their… cloud servers. Yeah, that’s it, cloud servers.
I mean, you should see their behavior. In fact you will see it because I’m going to share a picture of it with you. I just found a little history that is very disturbing indeed in terms of what it teaches about the present.
First, as a preamble, I must tell you that bank loan demand has been exploding over the past 4 months. We don’t know why, but it does not matter. It only reaffirms what I’ve previously shown you about rising interest rates. They stimulate loan demand and speculation until rates reach a level where they are truly punitive. We may not know precisely where that punitive point is, but we know we’re not there yet, simply because loan demand is soaring.
Fed talk is cheap. Money talks, and the growth in credit will keep the pressure on the Fed to keep tightening. I wouldn’t be surprised to see the economy continue to boom as a result, and consumer price inflation to pick up in the process. Contrary to conventional wisdom, a booming economy would be extremely bearish because the Fed would have no choice but to maintain tight policy.
Meanwhile, bankers are living in LaLa Land. Loan loss reserves continue to plunge as a percent of bank assets. They’ve reached the same levels they were at the top of the tech/internet bubble in 2000, and the top of the housing bubble in 2006. In 2000, bankers started to get more prudent before the stock market broke down. In 2007, the were late. Here today, they continued to sing Trololo right through the fourth quarter market break.
That is not a good sign.
Bank Loan Loss Reserves Are Near Bubble Record Lows
Banks’ loan loss reserves reached another post crisis record low as a percentage of loans outstanding. Loans outstanding have been soaring lately, but loss reserves are dead flat. There has been virtually no growth in total loss reserves since Q4, 2016. Apparently bankers think that there’s no risk in the system. This is bubble mentality. Bank loan officers are living in a fantasy world, where nothing ever goes wrong.
This is just another symptom of the steadily building systemic risk inherent in bubble behavior. Imprudent behavior goes hand in hand with confidence increasing into the realm of megalomaniac irrationality.
As further evidence of that, loan loss reserves as a percentage of total assets for large US commercial banks is back to the levels reached at the last two major stock market tops.
The 25 largest banks in the US comprise 57% of total US bank assets, and includes most of the parent banks of US Primary Dealers. The Fed reports this stat in its weekly H8. It gives us a detailed history that covers the last two major market cycles.
Loan loss reserves as a percentage of total large commercial bank assets have reached the levels reached in 1999-2000 and 2006-2007. These levels corresponded with the 1999-2000 and 2006-07 stock market bubble tops.
Interestingly, the bankers smelled the rat before the stock market rolled over in 2000. They began increasing loss reserves before that tech bubble began to deflate. In 2007, they had no such recognition. They didn’t begin to increase loss reserves until after the stock market broke late in 2007. It looks like they’ll be even later this time. They remained sanguine throughout the 4th quarter 2018 market crash.
This is not a comforting picture in the current environment.
It merely reaffirms my conclusion that we should not even think of chasing this stock market rally. There’s lots more downside ahead. I believe we’re only in the early stages of a bear market. There will be lots of ups and downs. Every rally will spur a wave of hope, only to be smashed against the cliffs of the next decline.
So I continue to recommend holding and rolling Treasury Bills, whose interest rates continue to rise, until the data and the market tells us otherwise. That’s a long way off.
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